Doom or Boom? Take Your Pick

January 11, 2001

By Christopher Farrell In early January, I attended the American Economics Assn. annual meeting in New Orleans. Like any professional conference, the sessions carried formidable-sounding titles like, "Equilibrium Marriage Markets," "The Empirical Relevance of Search Frictions in Labor Economics," and "Developments in Econometrics of Continuous Time Stochastic Processes." Yet the more than 7,000 economists gathered in New Orleans were eager to grapple with far more quotidian topics, too, such as whether the U.S. is hurtling toward a recession.

The answers, while laced with abstruse jargon and mathematical curlicues, echoed the overriding confusion among investors. Truth is, the economic outlook is unusually murky right now. Yes, the economy slowed at an alarming rate in recent months. And yes, the Federal Reserve's half-point cut in its benchmark interest rate will eventually do its bit to resuscitate an ailing economy.

But the agreement stopped there. Opinions were deeply divided on whether the "R" word will become a reality in coming months. You can count me in the "nay" column. I still think we're in a slowdown, not a recession.

CLASHING TITANS. Two economic heavyweights exchanged fire on the topic at one session that thrilled a standing-room-only crowd. One titan was Martin N. Baily, head of the White House Council of Economic Advisors in the twilight of President Clinton's Administration. Baily believes the U.S. is in a midst of a mild slowdown. The Nasdaq bubble is burst, and both business and consumer confidence have fallen sharply. The supply of cars, computer parts, clothes, and other goods is far greater than demand, although the economy should rebound nicely once business works off an inventory overhang. He noted that the Fed has plenty of room to ease monetary policy further since inflation isn't a problem -- a highly unusual circumstance in the post-World War II era.

Perhaps most important, the productivity gains created by the New Economy are structural, not cyclical. He presented convincing evidence suggesting that high-tech advances and organizational innovation have been raising productivity in the service sector, including wholesale trade and the securities industry. "No, I don't think we are headed into a recession, but into a period of slower growth," Baily said.

The opposing titan, Robert J. Gordon, economist from Northwestern University, didn't buy that scenario. Instead, he sees faint echoes of 1929 and 1974 -- the last century's two great economic disasters -- in the current downward spiral. The economy is squeezed between higher energy prices, as in 1974, and declining capital-spending plans, reminiscent of 1929. He also vigorously dismissed the idea that a New Economy can help cushion the blow.

LESS JUICE. Gordon doesn't believe the computer, telecom gear, and the Internet represent a cluster of major technological innovations that will permanently hike productivity growth -- and everyone's standard of living. He says they won't have the kind of impact that widespread use of electricity and the internal combustion engine, among other technological advances, did when the "golden age of productivity" dominated from 1913 to 1972. What's currently happening "is a severe macroeconomic event, and it will be hard [for the Fed] to control," he concluded.

Their interaction was lively, but I come down on Baily's side of the argument. I still think the odds of a recession are remote, although the economy's ability to withstand any more bad news is clearly diminished. The Fed is likely to ease several more times this year, and the economy's underlying productivity strength will become more apparent as 2001 ages.

Still, whether the economic optimists or the pessimists are right, another heavily attended session at the AEA conference offered this bright prospect: U.S. economic expansions are getting longer on average. The current expansion is already the longest in U.S. history, and will have lasted 10 years in February.

SHORT AND SHALLOW. Two factors seem especially critical to the trend toward longer upturns. First, under the leadership of Federal Reserve Board chairmen Paul Volcker and Alan Greenspan, the central bank largely operated monetary policy with an eye toward maintaining price stability rather than trying to focus simultaneously on the opposing goal of full employment. With containing inflation its No. 1 goal, the Fed no longer alternates between hitting the accelerator and slamming on the brakes.

The other reason is that over a long period of time, inventory control has become less volatile -- thanks to the rise of the information economy and technological advances. Taken together, it means that any downturn should be relatively brief in length and shallow in depth, with the subsequent expansion lasting for a long time. Farrell is contributing economics editor for Business Week. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online